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July 8, 2013

FASB Proposal on Life Insurance Accounting: Are Higher Premiums Next?

A Federal Accounting Standards Board (FASB) proposal to change the way companies account for life insurance contracts is gathering steam and may change the way companies reserve for and value policies internally. The FASB reform proposal is primarily designed to coordinate the way insurance policies are valued on financial statements worldwide. While there may be value in this coordination effort, some see the possibility of increasingly volatile profits for insurance companies on the horizon if the proposal is implemented in its current form. This has many in the industry wondering: Are today’s permanent life insurance premiums as cheap as they will ever be?

FASB Proposal Vs. Current GAAP Rules

The FASB proposal would essentially change the way insurance companies and other companies that issue contracts meeting the definition of “insurance contract” report revenue and liabilities on their financial statements. Under the FASB proposal, any contract that transfers significant insurance risk would be impacted—not just traditional insurance contracts issued by insurance companies. For example, the standards will apply to banks, guarantors and service providers who issue insurance-like contracts, as well as traditional insurance companies.

Currently, GAAP allows a company issuing insurance contracts to report income from premiums when the company receives those premiums. Under the proposed FASB rules, a company would be required to revalue policies each quarter and recognize income from premiums as coverage is provided, over time, rather than when those premiums are actually received.

Further, the assumptions that companies use in setting up required reserves with respect to insurance contracts they issue—such as life expectancy data and the probability that a policy will lapse—will need to be revised on a quarterly basis, as well. Industry experts also anticipate that more assumptions will be added into the mix under the new FASB rules.

Property and casualty insurers will be subject to new rules, too. While they currently use the “most likely” result to calculate their reserves, under the FASB proposal they will be required to take an average of the possible results based on the probability that each of those results will occur.

Possible Impact of the FASB Proposal

Because premiums will be recognized more slowly under the FASB approach (as coverage is deemed provided, rather than as premiums are received), some companies may see a corresponding slowing of growth in their reported revenues.

Further, many companies anticipate that such frequent revisions to the assumptions used in connection with life insurance contracts will lead to greater volatility in reporting, and adding even more assumptions into the mix will only exacerbate the volatility issue.

Importantly, these changes are likely to make accounting for insurance contracts more expensive for the companies that issue the contracts, and the increased costs may be passed along to customers in the form of higher premiums.

Conclusion

Though the methods in the FASB proposal would not become effective until 2018, such a significant change in the way companies account for insurance contracts will require extensive preparation. This type of preparation means that the current cost of issuing these contracts is about to rise, and your clients may begin seeing higher premium costs as a result.